Deal got cooked in committee? There might be hope….

“I think this is a pass for me…”

”I just can’t get over the…..”

”I like this guy, I just can’t believe the numbers…”

Sound familiar? Maybe you have heard worse… If not, then you are either brand new to lending, or you are a god amongst mortals in the SBA world. Legend has it that they do exist, but I have never met one in person.

So for the rest of us “demi-gods”, its imperative that we hone in our super powers and master the art of the deal. We will all encounter the “no” on a deal at some point, so here is some knowledge in overcoming those trials. Let’s explore five common weaknesses that any deal could have at any given point in time: collateral shortfall, poor credit history, insufficient historical cash flow, weak management experience, and poor personal liquidity. I intend on explaining why each weakness is a concern for the credit team, provide an example of what that looks like, and offer potential mitigation strategies. Additionally, there is a point when it might be appropriate to seek assistance from trusted colleagues in financing the deal.

Collateral Shortfall

Credit Team Concern: Insufficient collateral increases the risk for the lender, as it limits their ability to recoup their investment in case of default.

Example: A borrower seeking a $500,000 loan offers only $250,000 in eligible collateral.

Mitigation Strategy: SBA eligibility will naturally draw you to alternative collateral options such as equipment, inventory, or personal real estate. An option would be to consider obtaining additional collateral through partnerships or co-signers to strengthen the loan application. Sometime a minority partner might add the weight you need to swing the deal towards approval. For some lenders, the SBA guarantee is enough to overcome this shortfall, but for others, you may need to get creative. Cashflow add backs (when verified, documented, and logical), or a co-signer with tangible net worth would likely be the answer.

2. Poor Credit History:

Credit Team Concern: A poor credit history raises doubts about the borrower’s ability to repay the loan, signaling potential risk. Bad borrowing habits increase fear of default.

Example: A borrower has a history of late payments, defaults, or bankruptcy. Another one that I have run into lately is just imprudent borrowing. Did your borrower drain the business of capital in the form of distributions in the previous year, and now they need to borrower expensive money to fill the void? This can put the business into an ugly spiral so it will make the credit team nervous.

Mitigation Strategy: Provide a thorough explanation for the credit issues and highlight steps taken to rectify past mistakes. Strengthen the application with positive credit references, co-signers, or collateral that offsets the credit risk. Additionally, actively encourage the borrower to improve their credit score by addressing outstanding debts and making timely payments. Look for overweighted credit card and revolving balances and potentially condition for higher cards to be paid off before close. Have a call with the borrower and us this as an opportunity to educate them on how to be a reliable borrowing partner.

3. Insufficient Historical Cash Flow:

Credit Team Concern: Limited or inconsistent cash flow raises doubts about the borrower’s ability to meet loan repayment obligations.

Example: A business with irregular revenue streams or inconsistent profitability.

Mitigation Strategy: Prepare a compelling business plan that outlines strategies for generating consistent cash flow. Provide detailed financial projections, demonstrate cost-cutting measures, highlight potential revenue streams, and emphasize any pending contracts or partnerships that could positively impact cash flow. Spend the time spreading the expenses. Look for irregularities that might indicate a one time expense or other other change in the business that might smooth out the fear of future failure. Overweight the collateral where possible and lean on the management experience of the borrower to explain how any prior weaknesses would not be perpetuated going forward.

4. Weak Management Experience:

Credit Team Concern: Inadequate management experience increases the risk of mismanagement, leading to potential financial difficulties for the business. With rates increasing, and fulfillment and COGS skyrocketing across multiple industries over the last few years, Credit Team members have become less optimistic about the stability of previously strong businesses.

Example: A borrower lacks prior experience in managing a business or industry-specific expertise. Direct or indirect experience in the industry that are purchasing the business is minimal or non existent.

Mitigation Strategy: Highlight relevant qualifications, transferable skills, or educational background that can compensate for the lack of direct management experience. I literally have the borrower write a letter explaining to me the following: 1) Why are you buying this business? 2) What experiences do you have in your past that would make you a good fit for maintaining the success of the business you are looking at starting/buying 3) Draw a line from the exact places you have worked, your role there, and how it relates to your ability to manage the business. Any prudent underwriter will sniff out a BDOs attempt to story line this themselves and should be asking the customer these questions. So beat them to the punch and THINK LIKE AN UNDERWRITER! Next, if this letter doesn’t do the trick, consider encouraging the borrower to partner with an experienced co-manager or to seek out a mentor who can provide guidance and support. Sometimes a contract with a consultant and key employee could push the deal over.

5. Poor Personal Liquidity:

Credit Team Concern: Limited personal liquidity implies a lack of personal resources to support the business during challenging times. Guess what? We are in very challenging times

Example: A borrower has minimal personal savings or high personal debt. Some lenders consider a minimum dollar amount based on the loan size, or a percent of the loan amount, or even a certain number of months worth of payments.

Mitigation Strategy: If your credit box allows it, make a case for adding in a larger amount of working capital. SBA has the room in their policy to do this with an adequate explanation and fund controlling when necessary. I have had numerous conversations with borrowers, credit managers, and other banks to see what would work. I use a model of 2 months worth of operating capital as adequate excess working capital to help offset personal liquidity weakness. This all assumes that the cashflow can support the add. You can show that you borrower has a solid understanding of the business’s financial needs. Show a contingency plan for potential cash shortages and outline a backup source of the borrower’s personal funds or credit. Showcase their personal financial discipline and commitment to the business by contributing personal savings or seeking additional investors.

When to Cut Bait

Sometimes, despite your best efforts, certain weaknesses may persist, making it challenging to secure the SBA 7(a) loan. In such cases, it may be appropriate to cut bait on the deal and seek assistance from trusted colleagues who specialize in financing deals similar to yours. They might have access to alternative financing options, industry-specific expertise, or relationships with lenders who have a greater appetite for risk. Network as often as possible and find the “lending buddies” that you can trust. Don’t forget to follow your bank’s and federal policies on sharing any information about a deal. Be honest and up front with the customer and get their permission to do any of this.

Mitigating weaknesses in your SBA 7(a) loan application requires a proactive approach and patience. Be humble and teachable. Ask questions to better understand the credit teams’ hang ups. Don’t argue or try to undermine that opinion with snippy or aggressive responses. Seek harmony in your dialogues and find the right attitude to make the deal work. By identifying potential weaknesses as early in the game as possible, and spending the time to package in some mitigations, you can also show your team that you are interested in more than just your next commission. Remember, it’s crucial to present a compelling case that showcases the borrower’s commitment to the business, strategic planning for the realities that will occur, and their determination to succeed.

I’ve got your back if you ever want to discuss strategies to get a deal to work. It’s probably my favorite part of the job!

Good luck my fellow SBA Demi-gods!